Hedge Funds: The Road Back

John Paulson, whose fund was up 38% in 2008, has criticized fellow managers for invoking gates, and Leon Cooperman, who runs Omega Advisers, told The New York Times "you'd have to lower me into the ground before I'd put up a gate."

In my view, erecting gates is not ideal but defensible for a manager, since the possibility is fully disclosed to investors up front. However, it's deplorable that so many hedge fund managers have recently put up gates and then continued to charge fees after doing so. That certainly hasn't engendered goodwill with investors.

Among the funds still charging full or partial management and performance fees after erecting a gate, according to several industry participants I've spoken with: Citadel, Cerberus, and Highbridge Capital Management. One fellow manager expressed deep frustration at this practice of charging fees post-gate: "It's almost criminal. It gives all of us in the industry a bad name." Some funds are doing the right thing: Farallon is not charging fees to its investors kept in by their decision to use a gate last fall.

And, of course, just as no one is paying attention to the consumers who never got themselves into a loan they couldn't afford, let's not forget the many funds that had down years in 2008 and yet imposed no gates. They've given up fees on capital that left but could have been forced to stay. Some of the funds taking the high road are Atticus, Clarium, Harbinger, Maverick, and Tremblant. These funds faced the same "unprecedented" or "Perfect Storm" market conditions and yet were still able to maintain adequate liquidity and confidence in the marks on their positions in order to pay out requested capital to their investors. These funds are taking the long-view on this issue and will benefit in future fund-raising when this current down cycle turns.

Pay for Performance Works

Hedge fund critics are quick to jump on the issue of manager compensation. Critics say hedge fund managers should always make money, no matter the market or the strategy being followed. But not every hedge fund manager is following an absolute return strategy. One of the great things about hedge funds is that there is such a diverse choice of strategies and exposure levels.